Warranties and indemnities play an integral part in the process of selling a business. They provide the buyer with assurances about potential future outlay after the purchase has gone through, and help them deal with the unforeseen business-related issues that could arise.
In the case of a limited company, purchasers take over the existing and contingent liabilities when they buy the business, but some of these liabilities may not be obvious at the time of purchase.
For this reason, the buyer will seek warranties and/or indemnities to protect themselves, whereas, as a seller, you will want to minimise your exposure to the risk of future claims.
What are warranties and indemnities?
A warranty is a written statement provided to the purchaser to back up claims you have made about the business during the sales process. The buyer may not easily be able to verify your claims and statements when they sign the sale agreement, so a warranty provides them with some protection in this respect.
Indemnities, on the other hand, offer security for the buyer from known and specific circumstances that are defined within each indemnity – this makes you liable to cover the buyer’s losses without them having to make a claim against you.
Which warranties and indemnities might you need to provide?
Your purchaser will request warranties covering commercial, legal and financial aspects of your business. The list of warranties can be extensive, and may include the following areas:
- Legal disputes
- Accounting and other financial information
- Machinery and equipment
- Employees and pensions
- Intellectual property rights
- Property and other assets
- Tax issues
When the buyer carries out their due diligence, you provide them with a range of information on which they base their decision to purchase, so they will naturally want a warranty that the information was accurate and up-to-date.
Similarly, if a piece of machinery on which the business relies is not in good condition, your buyer will require a warranty to this effect to prevent them incurring repair costs post-sale.
Your purchaser may require indemnities to cover certain situations, including:
- Ongoing legal disputes with customers or clients
- Existing employee disputes/tribunals
- Litigation regarding a product
- Tax liabilities
You will want to limit the scope and extent of indemnities where possible, and ensure they relate to specific instances to reduce your potential liability.
Warranties and indemnities are essentially a method of allocating risk in the sale/purchase process. They mitigate the risk for buyers that you have misrepresented your business in some way, but by disclosing information surrounding a warranty you can speed up the sale process whilst also limiting the risk of a future claim.
Jeff Barber is a partner at Selling My Business he specialises in business disposals and acquisitions and has over 30 years of experience.